Jewellery demand and gold prices: A correlation

Last Updated: Tue, Jan 31, 2012 12:16 hrs

India, which continues to surprise the world with its appetite for gold jewellery, saw demand for the adornment slipping 26 per cent to 125.3 tonnes in the third quarter of 2011. Even then, the managing director of Gitanjali Gems Mehul Choksi said in an interview with Reuters that last year closed with Indian gold jewellery demand rising between five and seven per cent. The third quarter demand slippage was largely due to seasonal dip in buying, local volatility in precious metal prices and high inflation, according to the World Gold Council (WGC).

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Choksi's forecast of Indian jewellery demand growing 10-15 per cent this year without being impacted by slowing economic growth will no doubt be encouraging for the gems and jewellery sector that provides employment to over 1.8 million people. But there is a caveat in the pronouncement that the more benign demand growth we saw last year will 'once again catch up the momentum' as prices of gold are to come down. The point is not to be missed that Choksi made the remark after the government virtually doubled the import tax on gold.

Interestingly, China overtook India as the world's largest gold jewellery market in the 2011 third quarter when its consumption year-on-year rose 13 per cent to 131 tonnes, fuelled mainly by buying in smaller cities. If China proved more than a match for India in jewellery buying in one quarter, its preference for gold for investment purposes is becoming increasingly stronger. Australian investment bank Macquaire says it is likely that in the next few years China will leave India behind to become the world's largest gold consumer. India will perhaps not mind this dethroning as its recent import duty revision is intended to discourage large volume inflow of gold, seen as an idle asset.

There is more than one opinion as to how gold prices will behave as we go forward. One thing is clear: the remarkable price performance of gold in recent times has been largely due to the global investment community putting its faith in the metal. Its status as a safe haven or the investment of last resort has remained largely intact in spite of some liquidation of gold position for safety of the appreciating dollar last year-end.

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Because of such liquidation, gold shed close to 20 per cent from its record high of $1,891.90 an ounce on August 22 through 2011 end. At that point, the metal travelled below its 200-day moving average for the first time since January 2009. Principally due to the pickup in investment demand since then, gold did recover some lost ground. According to a spokesperson for the world's leading precious metals consultancy Thomson Reuters GFMS, the politico-economic condition likely to prevail through 2012 will be the prop for a high level of investment demand for gold. No one expects the sovereign debt crisis in the euro zone to go away quickly as. the uncertainties surrounding the US and the West Asia will add to the lustre of gold. "Our belief is that negative real interest rates will remain a feature of this year, as will the possibility of quantitative easing by (the US) Federal Reserve and these issues together could encourage investor demand (for gold) to return to the market," says the spokesperson.

The premise being such, GMFS expects gold to approach $2,000 an ounce in this year's second half while prices in the first half are to "trade fairly weakly." Elaborating the point, the global head of metals analytics of GFMS says, "The euro zone debt crisis led some to seek out the dollar and US Treasuries as a least bad option. However, the re-emergence of US concerns, in particular any apparent need to adopt QE3 (quantitative easing) could really fire up the gold market. After all, gold's price spike last August/September followed from the US debt ceiling impasse and downgrade." And going a step beyond GMFS, an analyst with UBS is saying gold will average $2,050 an ounce this year. He arrives at the price on the premise of an unremitting sovereign stress, a likely recession in Europe, not so inspiring an outlook for other assets, unfailing central bank appetite for the yellow metal, prospects of further interest rates fall in Europe and continued low rates in the US. So where are the backers for Choksi's statement of jewellery sales to get a boost from gold prices falling this year?

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Choksi's hope of gold staging a retreat after a decade-long bull run is, however, likely to happen in 2013. Macroeconomic improvement next year by way of return to some stability in the euro zone, improvement in global economic growth and central banks gradually raising interest rates to tame inflation are to create condition for a fall in investment demand for gold. A GFMS official says interest rate rises will "introduce an opportunity cost for holding gold and that will result in some liquidations". Choksi's argument that there is a correlation between gold prices and jewellery demand holds good. In a situation of loosening of investment demand, the jewellery sector will support a new floor for gold, caused by rises in mining costs.

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